Newsletter May 2016
May 6, 2016
The second quarter kicked off on a positive note with April initially building on March’s momentum. The month ended on a bit of whimper, however, as investors fretted about the outlook for earnings and concerns regarding defaults mounted. Overall, though, markets were remarkably resilient in the face of enduring macro noise and uncertainty, including the deliberations of key central banks, monetary policy disappointment out of Japan and impeachment news out of Brazil
Commodities converge
The key narrative of the market recovery continued to hinge on positive performance by commodities. US WTI Oil rose by close to 20% for the month, while Brent added 16%. The CRB Index gained 8.3% on the month as precious and industrial metals rose along with agricultural commodities.
Earnings season was disappointing, particularly in the tech sector, as Apple reported a slowing in iphone sales. Banks staged a decent recovery, however, suggesting that the previous weakness in the sector and discussed last month by us may have been somewhat overdone. Little changed in terms of the interest rate path, which has been widely cut in half in the US, despite a buoyant jobs report and other positive macro data. Overall markets were in mildly positive territory with the S&P ending the month +0.4%, the DJ Stoxx 600 up by 1.9% and the MSCI Emerging Market up by 0.6%, with the strongest performers in Brazil (+7.7% in local currency terms) and Russia (+4.5% in local currency terms).
High yield and EM snap back
The high yield market endured quite a snap back since the beginning of the month with rallies particularly in effect in energy (E & P names rose by 13%, oil field producers up 12%, broader energy names up 10% and metals and mining up 8%). This broad undercurrent drove high yield returns across the sector. EMD too saw a return in demand, with the EM Bond ALL index now up 11% for the year, led by bonds in EEMEA (up 10.7%) and Latin America (up 15.6%). In our meetings with managers this year it is clear that EM currencies are now considered to be “cheap” following last year’s surge in the USD, and this is driving a pick-up in interest in the strategy. Emerging markets continue to trade at a large discount to developed markets, having underperformed by over 5 years. However, now with a lower contribution of energy and materials to the overall market (13.1% today, versus a high of 37.4% in June 2008), and an increase in the contribution of “services” to EM economies, the value is considered to be quite compelling. Time will tell if pundits such as PIMCO and GMO are correct, or if this underperformance will persist. We continue to be of the view that a floor under commodity prices will continue to spur confidence in EM, despite the regions lower reliance on the resource sector.
April Armageddon
Hedge fund managers navel gazing on their poor year to date performance (The HFRI Fund of Funds Strategic Index lost 3.6% for the first quarter) centered on poor net exposure management and stockpicking on the part of equity managers. Negative momentum did not help matters and a risk off quarter for credit led many suffer significant losses early in the year. For managers focused on merger arbitrage, April was quickly termed April Armageddon, as a number of high profile deals broke. Early in the month Pfizer-Allergan merger was scrapped as the time was called on tax inversions. – In early May we learned that Baker Hughes/Halliburton merger failed for antitrust reasons. Deal activity is down by 22% year to date, which is leaving slim opportunities for event driven managers to actually put on deals.
Performance in the fund was slightly negative for the month as the US dollar weakened against the Euro and many underlying strategies failed to participate in the renewed positive momentum that drove higher beta names. CTAs in particular were weak as government bonds sold off globally and currencies surprised, with the Yen and the GBP strengthening, while the AUD fell on fears of a rate cut. The unexpected strength in energy and resources also caught out trend followers who had been short much of the oil complex.